Tax-Free Exchanges make sense when federal and or state capital gains taxes and recaptured depreciation exist. Are they really tax free? No, the taxes are simply delayed or postponed until the replacement property sells. Another 1031 exchange can be initiated as many times as desired continuing to defer the capital gains tax.
Three Easy Steps to Determine Capital Gains
Adjusted Basis is determined by
Original Purchase Price
Plus Improvements
Less Depreciation
Realized Gain is determined by
Sales Price
Less Adjusted Basis
Less Selling Expenses
Taxes Due are determined by
Recaptured Depreciation: Multiply the depreciation taken by 25%.
Federal Capital Gains: Subtract the depreciation taken from the realized gain. Then multiply the remainder by the capital gain rate for short term rate or ordinary income rate if asset is held for less than one year and a day. If longer multiply the remainder by the long term rate or currently 15% as of November, 2010.
State Capital Gains: In Indiana, the state capital gains rate is applied to the entire realized gain. Each state may determine their gains differently.
Add the three numbers together and the total represents what is deferred in a 1031 exchange. Some states do not impose a state capital gains tax, consequently, add the two numbers to determine the tax that can be deferred.
What is Capital Gains
Capitals gains is the tax on the investment income or profit earned from holding or owning real or personal property. Capital gain is triggered when the asset is sold resulting in a tax obligation if as determined above a capital gain exists. Recaptured depreciation is determined by taking the total amount of depreciation itemized on federal income tax returns multiplied by 25%.
To learn more exchange tips, download a free guide that also includes
- FOUR Exchange Rules
- What is and is not eligible for a 1031 exchange
- Identification Rules
The use of the tax free exchange is becoming an increasingly popular tool among real estate investors and owners of construction equipment, business aircraft, artwork and gold and silver bullion who are looking to reinvest 100 percent of the sales proceeds and debt retired from the sale of a property. The tax free exchange, also known as a 1031 exchange, is ultimately a tax delayed exchange because it allows the taxpayer to delay the payment of tax on any capital gains realized and recaptured depreciation until the replacement property is sold. Completing a tax free exchange is not a simple process and there are several points that need to be known.